Ten keys to resolving SR&ED claims

9 minute read
28 February 2023

Scientific research and experimental development ("SR&ED") claims can present some of the most complex and challenging tax disputes, requiring a practical and pragmatic approach. Here are ten keys to successfully resolve SR&ED disputes.

1. Focus on the substantive issues

It is best to keep the focus on the substantive issues. As with many tax disputes, it is not uncommon for there to have been some misunderstandings, miscommunications or worse between the taxpayer and the Canada Revenue Agency ("CRA") auditor. Taxpayers often complain that the CRA auditor, when considering the SR&ED claims, was unfair, arbitrary or capricious. At the same time, CRA auditors often complain that the taxpayer delayed responding and/or was unresponsive to reasonable requests for information, documents and other supporting materials, leaving them in the untenable position of being unable to properly assess the merits of the SR&ED claims. Rather than risk becoming embroiled in this futile or even counterproductive finger pointing exercise, it is always advisable to agree with counsel for the CRA to set aside those issues, freeing up the parties to instead concentrate on what really needs to get resolved.

2. Develop settlement negotiation protocol with sample projects

In appropriate cases, especially ones involving a large and unwieldy number of SR&ED projects, an effective strategy, to circumvent full blown litigation, is to develop an agreed upon settlement negotiation protocol, involving sample projects, to inform settlement negotiations for all of the projects in issue. Counsel for the CRA are reasonable and in the right situation are amenable to this approach. It is important that the parties are able to agree that the sample projects fairly and reasonably represent all of them. The concept is basically to disregard the sometimes contentious reasons why full representations were not made to the CRA auditor and instead allow the taxpayer a new opportunity to try to persuade the CRA, based on support provided for the samples, that all of the projects are eligible and should be approved.

3. Freeze frame the litigation

Despite a notice of appeal having already been filed with the Tax Court of Canada ("TCC"), it can be most efficient for all of the subsequent procedural steps in the litigation to be deferred, pending the outcome of the settlement negotiation protocol. A request for such a deferral is ideally made jointly on behalf of both parties. The TCC can be amenable to such a request, as a means to conserve precious judicial resources, provided that the TCC is given sufficient details of a demonstrably robust settlement negotiation protocol, to convince the TCC that there is a reasonable prospect of settlement.

4. Marshal the supporting facts

An integral element of an effective settlement negotiation protocol is for the taxpayer to marshal all of the available facts and documents to support the claim for eligibility of the sample project(s). This often requires a thorough search through old documents, computer records, drawings and prototypes. Although this can be a painstaking, time consuming and expensive process, it becomes critical to put the taxpayer's best foot forward, once the CRA has agreed to engage in settlement negotiations. The commonly seen tendency to wait until later stages of the litigation to do the hard work of compiling everything, due to cost or other considerations, must be avoided.

5. Contextualize the records retained

It is important to explain why the records that have been retained are less than complete, a common challenge in SR&ED cases. The apparent shortcoming typically results from the projects having been completed in a "shop floor" context, with pressing exigencies around production scheduling and cost constraints, with no available excess capacity for taking the necessary time to record all of the steps taken and results observed. Providing this context can help make the CRA and if necessary the TCC less dogmatic when seeking a detailed record of the hypotheses tested and the results, which is part of the test for determining eligibility of SR&ED expenditures.

6. Retain an expert

It is critically important that an independent external expert be retained to support meritorious SR&ED claims being advanced. The technical lead(s) for the subject project(s), having conducted the experiment(s), almost invariably benefit from the most intimate familiarity with the project(s) and they often have impressive credentials. As such, they are typically the subject matter experts and are often put forward to explain the technical aspects of the project(s) and specifically why the criteria for determining eligibility (including the presence of technological risk or uncertainty and technological advancement) have been met. This leaves them, however, essentially defending their own work. Given this lack of objectivity, it becomes more difficult to convince the CRA and ultimately the TCC, based solely on their statements, which can be perceived as merely self-serving. This difficulty is compounded by the practical operation of the reverse onus on taxpayers to disprove the assumptions underlying the assessments that typically denied the SR&ED claims. An independent expert, who cannot be criticized for lacking objectivity, can help overcome these challenges.

7. Win the "battle of the experts"

The old saying is that an expert is someone who knows more and more about less and less. To support meritorious SR&ED claims, we always strongly recommend identifying and retaining the leading available relevant subject matter expert(s). In our experience, such experts are typically available at a reasonable cost. The taxpayer is often aware of the leading relevant subject matter expert(s) and this can be a good starting point for the search. It can also be fruitful to ask potential experts for referrals of other potential experts, since it tends to be a relatively small community. Both the CRA and if necessary ultimately the TCC will find reports from leading independent subject matter experts helpful and compelling.

8. Do not have the expert purport to opine on the ultimate issue

It is not appropriate to ask the expert to provide an opinion that the subject expenditures qualify for SR&ED purposes. This is the ultimate issue to be determined and both the CRA and the TCC will disregard such an opinion. Instead, the expert's opinion should focus on the technical aspects, requiring specialized subject matter knowledge, including whether the projects involved technological risk or uncertainty that could not be resolved using routine engineering methods, whether a technological advancement was achieved and whether the type and amount of documents and other records that were retained are commensurate with what would typically have been prepared and retained.

9. Distinguish scientific research versus experimental development

In the right case an argument may be advanced that a distinction exists between scientific research versus experimental development and that the two concepts may have practically been conflated, especially relating to applying the SR&ED eligibility criteria relating to documentary requirements. We have experience working with expert opinion evidence supporting the proposition that there is a long established and fundamental difference between scientific research and experimental development and that these concepts have sometimes been effectively merged, which can operate to prejudice taxpayers.

10. Consider a contingency fee arrangement

SR&ED TCC appeals can be suitable for contingency fee arrangements, since they seek tax credits. The fee can accordingly be based on a percentage of the tax credits recovered. We have seen cases where substantial amounts have been recovered, using a contingency fee arrangement, where the taxpayer, when considering the prohibitive cost of litigation, had otherwise thrown their hands up in despair and would have foregone pursuing their claim, which turned out to be viable. This kind of arrangement can make it financially practicable for taxpayers to retain experienced counsel to successfully pursue meritorious SR&ED claims.

Should you have any specific questions about this article or would like to discuss it further, you can contact the author or a member of our Tax Dispute Resolution Group.

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